EUR Into ECB: How Low Can It Go? - Credit Suisse

The ECB’s 22 January decision on QE is clearly the dominant theme in the FX market, notes Credit Suisse.

"The bottom line is that market expectations are for a sovereign QE program of at least €500bn. And the probability is likely skewed to something more aggressive, either in terms of size (numbers up to €1tn being mooted by some), type of assets purchased (risk sharing via the ECB preferred to national central banks leading the charge) or timing (quicker implementation being seen as better)," CS adds.

"Our central scenario is that most roads still lead lower for the EUR at this time. Here are three possible outcomes to consider," CS argues.

1) The ECB broadly meets market expectations: This should translate into a probably stable but perhaps even modestly higher EUR near term, with lower implied volatility levels and a less-skewed risk reversal profile. This would not alter the longer-term downtrend in the EUR, but it might transform it into “slow but steady” from the more volatile profile seen so far in 2015.

2) The ECB beats market expectations: EURUSD would probably fall quickly in line with how implied volatility and risk reversal skews are priced.

3) The fails to meet expectations: A knee-jerk EUR jump of 1%-2% would be likely, justifying the shift higher in implied volatility over the past week, after which the broader downtrend should again resume as long as the market gets enough bandwidth to be able to price in the likelihood of the ECB coming up with more measures down the line.

"For these reasons, we have been EUR bears for some months as we have anticipated a more conventional phase of EUR weakness based on eventual ECB balance sheet expansion and monetary policy divergence, especially relative to the Fed," CS concludes

In line with this view, CS forecasts for EUR/USD stand at 1.12 in 3m and 1.05 in 12m.

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